Top 300 locations alone could be worth $40 a share, analyst says

AndriaCheng

NEW YORK (MarketWatch) — J.C. Penney Co. has a daunting task ahead of it in persuading investors that Chief Executive Ron Johnson’s troubled turnaround strategy can still work, but the company, according to an analyst, could be bailed out by the real estate it controls.

ISI Group analyst Omar Saad has calculated that the retailer’s
JCP, -0.52%
top 300 store locations alone could generate $40 a share of enterprise value, with its remaining 800 locations worth another $6 a share. On the New York Stock Exchange, the company’s stock — having peaked at $86 in 2007 before sliding to $32 in November 2011, when Johnson joined, and as low as $14.20 recently — jumped 7.5% to $16.65 in Monday trading, making it the biggest gainer among the S&P 500.

Bloomberg News/Landov

Penney CEO Ron Johnson arriving earlier this month at a New York courthouse to testify in a dispute between his department-store chain and rival Macy’s over Martha Stewart merchandise.

Why? The company’s average occupancy cost is only $4 a square foot, far below the average of $70 per square foot of surrounding rents in its top mall locations, the analyst said.

According to Saad, Penney could theoretically transform those top 300 locations into a premium real-estate investment trust under a new name and sublet the space to brands and other retailers that would be interested in paying a below-market rate of $40 per square foot, generating about $1.2 billion of rental income and resulting in $10.8 billion in enterprise value, or $40 a share.

Penney, said Saad, would allow those brands to control their inventory, personnel, checkouts, merchandise and fixtures. One model, he said, is Asian department stores’ concession-style, self-operated shops within shops.

“Investors may be overlooking an intriguing alternative outcome,” he said. “JCP would effectively collect a risk-free, high-margin, steady stream of rental income, while simultaneously eliminating fashion and inventory risk.”

Wall Street skepticism

Still, the prospect of Penney’s pursuing Saad’s Plan B was met with skepticism.

“Who’s going to want the third floor of a J.C. Penney store?” asked J.P. Morgan analyst Matthew Boss. “Given the JCP store model isn’t generating any traffic, why would [a Pacific Sunwear, for example] take the space? I don’t see why you’d do it. I don’t know If landlords would be behind them doing it. It still comes back to the same thing: How is it different from what it’s already doing today? If it’s not working as it is, I don’t know what would make Plan B work?”

Boss, however, said the company does have “some real-estate value,” in that its 426 company-owned stores, if sold, could be worth $11 a share.

“The real-estate opportunities for them is more likely to sell some stores to potentially fund the transformation,” he said, adding that questions would center on what rate amd prices the locations would be sold at and who the buyers would be. “The bottom line is, they have to draw the traffic,” Boss said. “Sales are going to tell the story here.”

Boss added that the company is carrying $13.50 a share in debt.

In his scenario, Saad said J.C. Penney could continue to operate the remaining 800 stores as traditional department stores. Assuming that those stores can improve sales per square foot to $100 and that their operating margin swings to 3% from a current double-digit negative percentage, that business could generate about $8 billion in sales and $240 million in operating profit, leading to a contribution of 70 cents to earnings per share and representing $6 a share in value.

Amid plenty of concerns about whether Johnson, on a short leash with Wall Street, would have enough money to fund his transformation of the company featuring shops ranging from Joe Fresh to Liz Claiborne, Saad said the Plano, Texas–based retailer has 37 months’ worth of liquidity remaining, assuming it posts flat comparable-store sales. However, the breathing room shrinks to 25 months if the company continues to suffer 20% sales declines.

Separately, Oppenheimer said in a note Monday that its store tours over the weekend suggested customers were reacting positively to Penney’s Joe Fresh launch Friday.

“Overall we were impressed with what we found,” said analyst Brian Nagel, who lowered his rating on the stock earlier this month. “Any significant consumer adoption is likely to take time. We remain optimistic that over time the repositioning of JCP should prove successful. A turn still seems a ways off, and near-term risks for the chain abound.”

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